Why profits per equity partner are not a reliable way to compare law firms

This article is a rather belated companion to one I wrote a while ago about how important retention rates are when assessing the strength of a firm and what future it might offer you. This time we are going to have a look at the other supposed great barometer of the worth and prospects of a firm, the profits per equity partner or ‘PEP’ as it is generally known in the business. This figure at its rawest is designed to measure how profitable a firm is for its owners – it is the profit a firm makes after all other costs have been accounted for, divided by the number of partners with equity. The idea is that the bigger the profit, the better the financial health of the organisation. I will argue that (as with retention) this represents a possibly useful, but not totally reliable guide to a firm’s success and should be used, at best, as one indicator among many when assessing the suitability of an organisation with whom you are thinking of throwing in your lot.

Let’s first look at how it is calculated. The raw material is the information that firms must (or choose) to release. This will be related to revenues, turnover and beyond what is released in officially filed accounts. Firms may well release a figure for PEP, but there will certainly not be anything like a standard definition for this, so comparing firms is immediately a problem. And of course all partners are not created equal. In a traditional firm, the people who have been there the longest will probably be earning more than the newest partners, and in the case of a firm that is a product of a merger, all sorts of Byzantine financial arrangements may be in place to keep the peace and ensure that the people who matter are happy. Clearly then, firms’ PEP figures are not all based on the same metrics – are they including salaried partners? What costs are taken into account (eg one off v underlying costs)?

We also need to think about other aspects of assessing pure profit. Profit per partner refers to the partners themselves – what their supposed cut is. They may well be making a fantastic living, but is there a down side? You certainly will not be a partner when you join the firm and (frankly) you probably never will be – trainee-to-partner within one firm journeys are getting rarer. So if these individuals are siphoning everything off as profit, then maybe the medium to long-term prospects of a firm are less rosy. Maybe the equity partners are underpaying the staff, not investing in up-to-date systems and technology, or neglecting their regulatory obligations.

Other measures of financial health are being used as alternatives now. Keep an ear open for profits per member, revenue per fee earner and other measures. There is plenty to find in the legal press and beyond. But remember that one-off figures in themselves are unhelpful. Look for trends over a few years; these are far better indicators of health and more to the point, stability. That’s what you want from a firm you may be joining up to four years from now!

In the final reckoning PEP (and its equivalents) are like retention rates: part of a much bigger picture. Make sure you are looking at it!